Experts: Cuomo's tax workarounds could be challenging – or illegal

In his budget proposal on Tuesday, Gov. Andrew Cuomo characterized the new federal tax plan as an “economic missile aimed at New York,” and suggested New York “get out of the way before it lands.” On Wednesday, the state Department of Taxation and Finance released a preliminary report providing some options for getting out of the way, such as replacing taxes with federally deductible charitable contributions to state-run funds or adopting a statewide payroll tax system in lieu of state income taxes.

The ideas are creative, but tax experts said they would be difficult to organize and possibly even illegal. The federal tax law limits the state and local property and income tax deduction to $10,000. Cuomo fears that will discourage business investment and cause a flight of the state’s highest earners who pay more than $10,000 in property and income taxes. However, the administration’s attempt to circumvent the cap may complicate an already convoluted tax system. Here are the most important policy proposals and the challenges to each one.

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Suggestion: Adding charitable contributions

In its first recommendation, the report suggests “encouraging additional charitable giving to the state,” which would then be federally deductible. While the new federal tax law capped the SALT deduction, it also raised the limit on charitable giving from 50 percent to 60 percent of a person’s income.

The report suggests creating charitable funds with designated purposes, and providing a tax credit to incentivize giving and offset a percentage of the contribution. This credit could be used to reduce the donor’s income tax liability.

The report compares these charitable donations to tax credits that some other states provide for donations supporting public schools and colleges, with the credits representing some percentage of the gift.

Problem: It may not be legal

Jared Walczak, a senior policy analyst at the Tax Foundation, which is a nonpartisan national research organization, said that IRS guidance indicates that charitable contributions must have “legitimate charitable intent” to be deductible, and not benefit the donor more than the recipient. Charitable contributions must also serve a public purpose to be deductible. Although these charitable contributions would serve a public purpose, by benefiting the donor they could be considered illegal.

Steve Wamhoff, senior fellow for federal tax policy at the nonpartisan Institute on Taxation and Economic Policy, gave the example that if a person gave $100 to a public radio station and received a mug in return, they would have to subtract the value of the mug when listing the deduction on their federal taxes.

“One would think that if the state government’s going to give you this tax credit that wipes out or dramatically reduces your income tax, that that’s a benefit that is worth clearly more than a coffee mug,” said Wamhoff, explaining that the IRS would have to decide whether the state government’s tax credit for the contribution makes it ineligible for federal deductibility.

Wamhoff also noted that while – as the report points out – other states provide tax credits for donations to public schools, this is not a binding precedent.

“The only approval on the IRS on that has been through an informal guidance,” Wamhoff explained.

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Suggestion: Adopting a payroll tax system

The report offers five options for adopting a “statewide employer compensation expense tax,” or payroll tax. The first two options are adopting a progressive statewide payroll tax and a flat rate payroll tax while maintaining the progressive income tax system.

In a payroll tax system, instead of having an employee pay an income tax based on their wages, an employer would take a tax from an employee’s paycheck which then would be federally deductible for the employer. Thad Calabrese, a consultant with the Citizens Budget Commission and an associate professor at New York University’s Wagner Graduate School of Public Service, said a progressive payroll tax would require employers to determine different rates based on an employee’s salary. In a flat rate system, the employer would pay the same tax for all wages, regardless of an employee’s income. The flat rate is easier to implement from an administrative standpoint, but it doesn’t differentiate between employees.

The third option presented by the report is to enact a payroll tax for employees above a specific wage threshold, such as those making $200,000 or more. Calabrese said that this was intended to offset the effects for higher earners, who generally pay more in income taxes and will be most affected by the limited SALT deduction. This is also true for the fourth option, which would levy the payroll tax on supplemental wages, such as bonuses.

“Again, the idea is that those bonuses tend to go to people who are going to be most affected by the loss of state and local tax deductions,” Calabrese said.

The final option for adopting a payroll tax system presented by the report is an employer opt-in system. Many businesses may not have employees affected by the limit in the SALT deduction. However, an opt-in would allow companies that do have highly paid employees, such as Wall Street brokerage firms, to choose to use the system based on the employees’ needs.

Problem: It could require lowering wages

The report does note several potential problems with shifting to a payroll tax system.

“Kudos to the officials at the finance office that came up with five different options to try to address this issue, all of which have shortcomings which they acknowledge, but this range of options demonstrates the shortcomings of each of them,” Walczak said. One such shortcoming is the impact that adopting a payroll tax could have on labor costs.

Calabrese said that for businesses to impose a payroll tax, they would have to reduce wages by an equal amount, otherwise the employer is just paying an additional tax. Even though workers would end up with the same take home pay, convincing them to accept lower gross income might be difficult.

“All you’re doing is converting income tax liability to payroll tax liability, so they’re held harmless,” he said. “But getting employees to say, ‘Yeah you can lower my salary’ – you know that’s not an easy task to do.”

Walczak – who called the proposals in the report complex and “almost Rube Goldberg-esque” – noted that lowering wages could be legally impossible because of contractual agreements, including those with labor unions.

“In all of these cases, and other cases where employees simply aren’t going to take a pay cut, this would be a significant increase in labor costs, which could lead to reduction in the labor force, something which I’m sure the state would be concerned about,” he said.

Problem: It would complicate the tax code to mostly help the affluent

As Wamhoff noted, this report is a preliminary one, and legislation hasn’t yet been proposed to adopt these options. But the options are incredibly complex, and largely benefit high earners affected by the limit on the SALT deduction.

“You have to ask yourself, what is the point exactly and who are they trying to help?” Wamhoff said.

Not all people affected by the SALT deduction are wealthy. In areas of the state with especially high property taxes, such as Long Island, many residents use the deduction. In his budget address, Cuomo said the new tax law would increase middle-class New Yorkers’ property and income taxes by 20 to 25 percent. But according to Wamhoff, New York’s wealthy residents are disproportionately affected by the cap on the SALT deduction, and they are the ones who would be helped the most by efforts to circumvent its effects.

“If that particular cap was repealed by Congress or if the state basically found a way to let their residents totally avoid it, we found that 67 percent of the benefits would go to the richest 1 percent of New Yorkers,” Wamhoff said, referring to his organization’s research that was done in response to a bill proposed by Reps. Pete King and Nita Lowey to restore the full state and local tax deduction.

Wamhoff added that the state should consider taxing the wealthy more, as many of them will enjoy lowered federal tax rates. “The obvious answer would actually be to raise taxes on the rich people who just got the biggest tax cuts under the new federal tax law,” he said.

Walczak said these proposals showed the complications in converting an academic exercise into actual policy. “The federal tax law is what it is,” Walczak said. “If elected officials in New York are genuinely concerned that, absent a subsidy for their state’s residents, that these residents would not put up with New York’s high tax rates, then perhaps they should be looking at those rates rather than trying to find a way to back into a reduced subsidy.”